Capital Markets

Rebirth for Commercial Paper

Companies that have held back their capital expenditures and improved their balance sheets are finding ''a more amenable borrowing environment.''
Stephen TaubFebruary 27, 2004

The growing demand for external funds to finance working capital will finally lead to a rebound in the commercial paper market for short-term financing, according to Standard & Poor’s.

The rating agency pointed to a January survey by the Federal Reserve, which found that domestic banks have reported an increase in inquiries by potential borrowers. S&P added that the Fed had noted increased customer investment in plants and equipment, as well as increased customer needs to finance accounts receivable and inventories. Until recently, corporations’ working capital had been increasingly financed by internally generated funds.

“In the commercial paper market, supply side conditions are favorable, with the ‘AA’ commercial paper discount rate hovering near a low of 1.00 percent, tightened discount rate spreads, and improved credit quality,” said Diane Vazza, head of Standard & Poor’s Global Fixed Income Research group, in a statement. “If the economic recovery continues, coinciding with a rise in inventory levels and capacity utilization, companies are likely to seek additional funding from the commercial paper market.”

The increasing demand for external funds halted the three-year decline in commercial and industrial loans, now hovering around $900 billion. Demand peaked at a record $1.1 trillion in commercial and industrial loans in February 2001; the current level roughly matches the outstanding amount in mid-1998.

The recent slowdown in the commercial paper market stemmed from a decline in capital expenditures in 2001, reducing the need for short-term financing. Corporations paid more attention to repairing their balance sheets from 2001 through 2003, mostly by holding back capital expenditures while internally generated funds climbed.

Over the past 20 and 30 years, the ratio of U.S. internal funds to capital expenditures averaged 90 percent; from a trough of 68 percent in 2000, the ratio has risen to 110 percent today, according to S&P. “The improved balance sheets helped create a more amenable borrowing environment,” added the rating agency.

Not everyone has it so good: six U.S. non-financial commercial-paper programs have been downgraded in 2004. Fourteen programs, concentrated in the telecommunications sector, are currently on CreditWatch with negative implications.